This document provides an overview of the evolution of international monetary systems throughout history, including bimetallism, the classical gold standard, the Bretton Woods system, and the current flexible exchange rate regime. It discusses key concepts like fixed versus floating exchange rates and outlines several international monetary crises like the Mexican Peso Crisis and Asian Currency Crisis. The document also describes the development of the European Union's monetary integration, from the European Monetary System to the establishment of the Euro currency.

1. The International Monetary
SystemINTERNATIONAL 2
FINANCIAL
MANAGEMENT
Chapter Objective:
This chapter serves to introduce the student to the
institutional framework within which:
•International payments are made.
•The movement of capital is accommodated.RESNICK
EUN /
•Exchange rates are determined.
Second Edition

2. Chapter Two Outline
2-2
 Evolution of the International Monetary System
 Current Exchange Rate Arrangements
 European Monetary System
 Euro and the European Monetary Union
 The Mexican Peso Crisis
 The Asian Currency Crisis
 Fixed versus Flexible Exchange Rate Regimes

3. Evolution of the
2-3
International Monetary System
 Bimetallism: Before 1875
 Classical Gold Standard: 1875-1914
 Interwar Period: 1915-1944
 Bretton Woods System: 1945-1972
 The Flexible Exchange Rate Regime: 1973-Present

4. Bimetallism: Before 1875
2-4
 A “double standard” in the sense that both gold and
silver were used as money.
 Some countries were on the gold standard, some on
the silver standard, some on both.
 Both gold and silver were used as international means
of payment and the exchange rates among currencies
were determined by either their gold or silver
contents.
 Gresham’s Law implied that it would be the least
valuable metal that would tend to circulate.

5. Classical Gold Standard:
2-5 1875-1914
 During this period in most major countries:
 Gold alone was assured of unrestricted coinage
 There was two-way convertibility between gold and
national currencies at a stable ratio.
 Gold could be freely exported or imported.
 The exchange rate between two country’s currencies
would be determined by their relative gold contents.

6. Classical Gold Standard:
2-6 1875-1914
For example, if the dollar is pegged to gold at U.S.
$30 = 1 ounce of gold, and the British pound is
pegged to gold at £6 = 1 ounce of gold, it must be
the case that the exchange rate is determined by the
relative gold contents:
$30 = £6
$5 = £1

7. Classical Gold Standard:
2-7 1875-1914
 Highly stable exchange rates under the classical gold
standard provided an environment that was conducive
to international trade and investment.
 Misalignment of exchange rates and international
imbalances of payment were automatically corrected
by the price-specie-flow mechanism.

8. Classical Gold Standard:
2-8 1875-1914
 There are shortcomings:
 The supply of newly minted gold is so restricted that the
growth of world trade and investment can be hampered
for the lack of sufficient monetary reserves.
 Even if the world returned to a gold standard, any
national government could abandon the standard.

9. Interwar Period: 1915-1944
2-9
 Exchange rates fluctuated as countries widely used
“predatory” depreciations of their currencies as a
means of gaining advantage in the world export
market.
 Attempts were made to restore the gold standard, but
participants lacked the political will to “follow the
rules of the game”.
 The result for international trade and investment was
profoundly detrimental.

10. Bretton Woods System:
1945-1972
2-10
 Named for a 1944 meeting of 44 nations at Bretton
Woods, New Hampshire.
 The purpose was to design a postwar international
monetary system.
 The goal was exchange rate stability without the gold
standard.
 The result was the creation of the IMF and the World
Bank.

11. Bretton Woods System:
1945-1972
2-11
 Under the Bretton Woods system, the U.S. dollar was
pegged to gold at $35 per ounce and other
currencies were pegged to the U.S. dollar.
 Each country was responsible for maintaining its
exchange rate within ±1% of the adopted par value
by buying or selling foreign reserves as necessary.
 The Bretton Woods system was a dollar-based gold
exchange standard.

12. The Flexible Exchange Rate Regime:
1973-Present.
2-12
 Flexible exchange rates were declared acceptable to
the IMF members.
 Centralbanks were allowed to intervene in the exchange
rate markets to iron out unwarranted volatilities.
 Gold was abandoned as an international reserve
asset.
 Non-oil-exporting countries and less-developed
countries were given greater access to IMF funds.

13. Current Exchange Rate Arrangements
2-13
 Free Float
 The largest number of countries, about 48, allow market forces to
determine their currency’s value.
 Managed Float
 About 25 countries combine government intervention with market
forces to set exchange rates.
 Pegged to another currency
 Such as the U.S. dollar or euro (through franc or mark).
 No national currency
 Some countries do not bother printing their own, they just use the
U.S. dollar. For example, Ecuador has recently dollarized.

14. European Monetary System
2-14
 Eleven European countries maintain exchange rates
among their currencies within narrow bands, and
jointly float against outside currencies.
 Objectives:
 To establish a zone of monetary stability in Europe.
 To coordinate exchange rate policies vis-à-vis non-
European currencies.
 To pave the way for the European Monetary Union.

15. The Euro
2-15
 What is the euro?
 When will the new European currency become a
reality?
 What value do various national currencies have in
euro?

16. What Is the Euro?
2-16
 The euro is the single currency of the European
Monetary Union which was adopted by 11 Member
States on 1 January 1999.
 These member states are: Belgium, Germany, Spain,
France, Ireland, Italy, Luxemburg, Finland, Austria,
Portugal and the Netherlands.

17. EURO CONVERSION RATES
2-17
1 Euro is Equal to:
40.3399 BEF Belgian franc
1.95583 DEM German mark
166.386 ESP Spanish peseta
6.55957 FRF French franc
.787564 IEP Irish punt
1936.27 ITL Italian lira
40.3399 LUF Luxembourg franc
2.20371 NLG Dutch gilder
13.7603 ATS Austrian schilling
200.482 PTE Portuguese escudo
5.94573 FIM Finnish markka

18. What is the subdivision of the euro?
2-18
 During the transitional period up to 31 December
2001, the national currencies of the member states
(Lira, Deutsche Mark, Peseta, Franc. . . ) will be "non-
decimal" subdivisions of the euro.
 The euro itself is divided into 100 cents.

19. What is the official sign of the euro?
2-19
 The sign for the new single currency looks like an
“E” with two clearly marked, horizontal parallel
lines across it.
It was inspired by the Greek letter epsilon, in reference to
the cradle of European civilization and to the first letter of
the word 'Europe'.

20. What are the different denominations of
the euro notes and coins ?
2-20
 There will be 7 euro notes and 8 euro coins.
 The notes will be: 500, 200, 100, 50, 20, 10, and 5
euro.
 The coins will be: 2 euro, 1 euro, 50 euro cent, 20
euro cent, 10, euro cent, 5 euro cent, 2 euro cent, and
1 euro cent.

21. How will the euro affect contracts
denominated in national currency?
2-21
 All insurance and other legal contracts will continue in force
with the substitution of amounts denominated in national
currencies with their equivalents in euro.
 Euro values will be calculated according to the fixed
conversion rates with the national currency unit adopted on
1 January 1999.
 Generally, the conversion to the euro will take place on 1
January 2002, unless both parties to the contract agree to
do so beforehand.

22. The Mexican Peso Crisis
2-22
 On 20 December, 1994, the Mexican government
announced a plan to devalue the peso against the
dollar by 14 percent.
 This decision changed currency trader’s expectations
about the future value of the peso.
 They stampeded for the exits.
 In their rush to get out the peso fell by as much as
40 percent.

23. The Mexican Peso Crisis
2-23
 The Mexican Peso crisis is unique in that it represents
the first serious international financial crisis touched
off by cross-border flight of portfolio capital.
 Two lessons emerge:
 Itis essential to have a multinational safety net in place
to safeguard the world financial system from such crises.
 An influx of foreign capital can lead to an overvaluation
in the first place.

24. The Asian Currency Crisis
2-24
 The Asian currency crisis turned out to be far more
serious than the Mexican peso crisis in terms of the
extent of the contagion and the severity of the
resultant economic and social costs.
 Many firms with foreign currency bonds were forced
into bankruptcy.
 The region experienced a deep, widespread
recession.

25. Currency Crisis Explanations
2-25
 In theory, a currency’s value mirrors the fundamental
strength of its underlying economy, relative to other
economies. In the long run.
 In the short run, currency trader’s expectations play a much
more important role.
 In today’s environment, traders and lenders, using the most
modern communications, act by fight-or-flight instincts. For
example, if they expect others are about to sell Brazilian
reals for U.S. dollars, they want to “get to the exits first”.
 Thus, fears of depreciation become self-fulfilling
prophecies.

26. Fixed versus Flexible
Exchange Rate Regimes
2-26
 Arguments in favor of flexible exchange rates:
 Easierexternal adjustments.
 National policy autonomy.
 Arguments against flexible exchange rates:
 Exchange rate uncertainty may hamper international
trade.
 No safeguards to prevent crises.